As many readers will know, I am not the greatest fan of stock markets. I consider most activity on such markets to be exploitative because of the asymmetry of the information available to investors. Much of it, from the pay directors take to the actions of most market managers, I consider to be rent seeking. The idea that equities provide strong returns is pretty much an urban myth, in my opinion, based on selective reading of data in those periods between market crashes.

There is quite a lot of evidence to support my view in an article by long-term and highly opinionated equity investor Terry Smith in the FT this morning. As he notes he did this based on ‘a research paper by Hendrik Bessembinder published in the September edition of the Journal of Financial Economics posed the question “Do Stocks Outperform Treasury Bills?” with some rather worrying conclusions for most equity investors.‘ I should make clear that the research is US based. I have no reason to think that performance in the UK is any different.

The main conclusions is that the majority of shares do not perform nearly as well as government bonds. It is an exceptional few that make it look as though shares outperform gilts.

Since 1977 the median new shares issued on the stock exchange has delivered a negative rate of return, even with dividends reinvested.

On average, a quoted security has a life expectancy of just 7.5 years over the 90 year period studied. No wonder short-termism is rife.

And as he notes:

Just five companies out of the universe of 25,967 in the study account for 10 per cent of the total wealth creation over the 90 years, and just over 4 per cent of the companies account for all of the wealth created.

So, what is to be learned?

First, the stock exchange is not a business funding mechanism: it is a business exit strategy for most companies.

Second, most people are fools to take part in this game.

Third, if you insist on taking part only invest in the best stocks.

Fourth, since you have no way of knowing which ones they are, invest in a market tracker.

Or fifth, buy gilts.

But whatever you don’t believe the story that the market deliver higher rates of return than government bonds: 96% of it does not.

64 comments

When 43 pushed the privatization of Social Security through more 401k and similar approaches my immediate thought was that he was rationalizing the transfer of wealth and increased fees to Wall Street. Someday there will be a post-mortem about Neo-Liberalism and that episode merits at least a footnote. To escape the memory hole.

Don’t forget that Clinton had reached a deal with Gingerich to privatize up to half of the Social Security Trust Fund in the stock market, which was only derailed by the Lewinski scandal. Clinton was scheduled to unveil this at the State of the Union address the week after the Lewinski story started to break, and pulled back because he was advised that if he were impeached he’d need the Democrats in the Senate to avoid conviction. Google “Robert Kuttner” “Clinton” and “Social Security” to get the details. There’s also a book called “The Pact” by Steven Gillon that documents the back channel negotiations, which were conducted by Erskine Bowles, Clinton’s last Chief of Staff.

It would have been the ultimate Neo-Liberal betrayal of the party of FDR, but we were saved by a blue dress. Amazing story, not nearly as well known as it should be. We might have been spared the Hillary Clinton phenomenon.

Remember that taxes don’t really pay for government expenses in a fiat system; don’t forget MMT.

Accounts are not real wealth any more than the map is the territory (CF Korzibsky and general semantics). The stock market, as well as the bond market, are accounting gizmos, and accounting is not actual wealth creation, and neither does owning stocks or binds produce anything real.

Obama had a deal sealed to shut down Medicare and roll it into Obamacare and start a 5 year winddown of Social Security. Then Occupy got rolling and he lost control of the narrative for 90 days and was worried that a real ‘American Spring’ might get rolling.

Anyone investing in bonds in the low interest rate environment that has prevailed these past ten years would disagree, I think.

I call rubbish on this article. Not my experience. My investing strategy is to follow the oligarchs. Invest in stocks that make money by destroying the planet. Take profits when things look toppy. Reinvest dividends.

Buy bonds at your own peril. Maybe when rates are in the 6% plus range but we’re a long way from that.

The time scale of the article is 40 years – in our current economy 40 years ago is ancient history. And they focus only on new issues, which represent a fraction of total market cap. And I doubt many financial advisors would agree with me as I a) don’t employ any of them; and b) find them to be a repository of groupthink and always to miss inflection points.

I dismiss anyone advising bonds in the current interest rate environment. Unless you want to end up with less money than you started out with.

while it’s great that you are succeeding in the market, remember that we have had 10 years of qe and stock buybacks. I hear student loan bonds are very lucrative if you’ve got enough dough to make a position…

On average, a quoted security has a life expectancy of just 7.5 years over the 90 year period studied. No wonder short-termism is rife.

This does not mean the average company goes bankrupt in 7.5 years. Acquisitions also remove quoted securities. I don’t see the link between how long a security is traded and whether or not the underlying assets are managed for long or short term.

The dot com bubble sure had it’s share of here today… gone tomorrow stocks but, I’m also wondering if they took into account many of the mergers and aquisitions that occurred during the lead up to the bubble’s popping.

1. During the initial IPO
2. If they issue new shares afterwards, which dilutes existing owners

Other than that, you are not, when you buy a share, sending money to the bank account of the firm that you are investing in. What are you doing? Sending money to the person who you bought the share from. It is pretty much speculation. Capitalists hate to admit this idea.

Also, companies that buy back shares or pay dividends are taking money of their cash flows and giving money to the shareholders.

In this regard, capitalism is not a good way to allocate capital. It can be used for various types of manipulation, an example being a share buyback right before executives cash in their stock options.

IMO stock markets in and of themselves both create and destroy “value” in much the same way that a casino does, including largely hidden social costs. While there is little in the way of public data to support either a pro or con view and setting aside issues of manipulation of market prices, the view that stock markets themselves create value by enabling price discovery is integral to neoliberalism. I agree with the view that the related long-term “financialization” of the economy contributes to recurring speculative asset price bubbles and leads to long-term economic stagnation while enriching a few.

“price discovery is integral to neoliberalism”
I would have thought it’s the exact opposite ?
(Perhaps your “indeed” was ironic ?)
It’s the inequality of information (ie price discovery) that makes the stock market so profitable for the “right” people.
The Fed’s years of QE is another factor that has made price discovery very difficult.

I believe that the concept of price ‘discovery’ is already an important element of neoliberal framing, and that Chauncey Gardiner has shared a profound insight. Discovery implies that there is a natural price, somehow prior to and independent of human/political intervention. The stock market is a way to embody the collective of individual ‘rational actors’, and give this collective transcendent power over individuals, corporations and nations. It is perhaps more clear when one looks at bond markets and the way they are used to ‘discipline’ nations whose fiscal policies diverge from the neoliberal consensus. The fact that the hand holding the whip is invisible is a feature, not a bug. The whipped feel the lash, les autres hear the crack and see the blood, but there is no recourse imaginable — because Markets.
Your point about information inequality is good, but I think that would be viewed in neoliberal doctrine as a minor flaw in the market, even if, for the main actors, it is the raison d’etre.

Yup, what the author describes as a flaw — “asymmetry of the information available to investors”, isn’t a bug; it’s a feature. But the real elephant soiling the room is who has access to all that free debt printed by the unaccountable private cartel we refer to as the Federal Reserve. Could you benefit from a zero-interest deferred-payment mortgage?

Even better “our” millionaire legislators are exempt from insider-trading laws and they in turn have immunized their investors. Clearly the most lucrative investment by far is political bribery. The new Wall Street Socialists have redefined capitalism and democracy as Orwellian doublespeak.

I agree — I think this post plays on its words. The stock market price for a stock indicates what speculators are willing to pay and sellers are willing to accept for the stock. These need have very little to do with the ‘value’ of the stock other than its ‘value’ in the stock market. That’s seldom been truer than in the current stock ‘market’. I’m not a very trusting sort so I don’t believe more than half the numbers in corporate reports. Many stocks stocks like Apple or Amazon tend to trade on ‘value’ instead of anything like what used to be called value. At a time when there seems to be no limit on the amount of money finding its way into the hands of the wealthy I’m not sure the selling of stock has anything to do with raising money for investments. Many firms can coin their own money through their many monopolies and monopsonies, and ‘retained earnings’ — a category I believe often labels earnings squeezed from the small sellers, suppliers, and labor thrall to the large firms. To me, asserting “Stock markets do not create value” is shorthand for a much deeper critique of our financialized stock markets.

Westinghouse in the days of George Westinghouse, General Electric in the days of Thomas Edison, Xerox in the days shortly after Chester Carlson … all created value. I like to believe that at least in some periods of the stock market their stocks represented and did not create but “shared” the value these firms invented and developed. I also like to believe at least some of the new issues these and other firms sold did indeed once help fund real investments in productive capital. But all that has become but romantic memory.

I believe the Corporate Management is busily engaged in cashing-out what real value remains within the firms they control and will continue doing so until all that’s left is a hollow shell servicing the bonds and notes the firm created as part of their liquidation process. The stock market is where speculators can bet against each other on the ebb and flow of prices moving toward a great twilight of our stock markets … and our gutted economy.

The stock market price for a stock indicates what speculators are willing to pay and sellers are willing to accept for the stock. These need have very little to do with the ‘value’ of the stock other than its ‘value’ in the stock market.

Well, there’s entertainment value, just like casinos and horse racing, but that isn’t what they’re paid for – unlike casinos or race tracks.

An Indiana paper (Indy Star? used to print the stock market numbers facing the horse race results. My father was not amused when I pointed that out, since investing in stocks was part of his job. I thought it was hilarious.

Realistically, financial “markets” are an overhead cost, part of your management system for the economy. Not saying whether it’s MIS- management.

They used to say you can make money if you are right 51% of the time. Such a narrow edge – because the reverse is also true. This is a good argument for not wasting time and money on the cherished institution of the market. Nancy Pelosi was blabbering on about all our sacred institutions (cows) trying to cover her fauxpaux when she tried to defuse the demand for single payer with her stumbling, tooth sucking comment that “this is a capitalist country” and therefore we simply canot have anything so cost effective as single payer. I’m convinced she doesn’t know her capitalism from a hot rock. So now, armed with this simple demonstration of how wasteful the whole idea of a stock market is, I’m thinking the Market is a very questionable institution. Much better to be highly selective and deliberate about stocks and stock companies. Not just in the share-buying but in the whole company concept. If returns on government bonds are the best choice then why would anyone get upset about “the debt”. It’s the best investment. And I am left to assume this is true because that money is spent on valuable things in the first place. I’m also thinking how to do an end-run around Nancy’s new Institution-patriotism with a movement to provide everyone with a medical credit card. Why not? Everything else, including Nancy’s paycheck and percs, are on credit. What a velvet revolution, no?

It comes down to defining the data set. You and the paper’s author define “stocks” differently. Bessembinder uses CRSP data (NYSE, NASDAQ and Amex; so no OTC which would only make the ultimate conclusions even worse). The Wilshire 5000 is a better proxy. The author draws individual selections from CRSP then compares them to equal and market cap weighted versions of the entire data set.

To make a long story short, there’s a lot of junk in the small and micro cap segments of the market. The SP 500 conveniently sidesteps this junk. Furthermore, rebalancing rotates the index into growing companies and out of declining companies. Small cap growth stocks that perform exceptionally well become part of the SP 500. The SP 500 itself is skewed to the mega caps. These are the companies producing the majority of the wealth. 4% of 26k is about 1,000 companies.

The paper goes on to reconcile how the stock market can have a positive risk premium while most individual stocks produce a negative risk premium. The stock market is a pyramid with trillion dollar Apple and Amazon on the top and thousands of doomed small and micro caps on the bottom.

I think that stock markets are reflective of value, they don’t in themselves create value. Certainly there is speculation and cheating, but in general, the value of a stock should increase as the value of the underlying business increases. Better to say that the price reflects the expected business in the future.

We’ve done fantastically well investing in stocks and mutual funds over the last 30 years. Not every fund went up. Not every stock went up. But the total gains far outpaced the losses.

Companies take money from the market by going public and by issuing new shares. They also hold some shares from some issues that are used to incentivize employees.

I think the original author sort of tilted the table by talking treating all securities the same. Likely the newcomers to the market are much smaller and have more risk of failure.

I’m also puzzled how they square this claim agains the historical value of something like he Russell 2000 index.

“Since 1977 the median new shares issued on the stock exchange has delivered a negative rate of return, even with dividends reinvested.” If this were true I’d expect to see a lot more red in the historical returns. Maybe the word “median” is doing some heavy lifting?

This data would seem to indicate that corporations have consistently earned money and these profits should be reflected in stock prices. (I don’t know if these are in constant dollars).

No correction from me. The stock-casino representing “free-market capitalism” has risen in lockstep with the Central Cartel’s QE. The evidence, if circumstantial, is overwhelming, with countless charts showing an almost exact correlation. Pretty hard to argue against causation.

The 1980s financial innovation of sheer unadulterated genius that enabled the cartel to buy the market — legalizing stock buybacks — a syringe for mainlining monetary heroin straight into market veins. This is the new efficient-markets theory called “hindsight price discovery”. You will discover the true price and value after insiders dump their pumped holdings

You forget that equities are a form of money which C-corps can create at will and don’t necessarily have fundamentals underpinning them e.g. Jbonds sold for stock by backs or abuse of risk tools to lower credit weighing and deals between the sell and buy side marry go round.

Don’t know what to make out of the comment about communists e.g. old school classical capitalists likened the financial traders to rats in the back alleys or bars they once traded in. Not to mention the propensity for the financial traders to blow themselves and everyone up with them like clock work. It has only been during the neoliberal period that the FIRE sector gained a veneer of respectability through broad spectrum PR.

Something of a reference point to the Australian experience.

If the general managers of the 12 banks that burst in 1891 and 1893 had kept paid clowns to make fun of the valuations of city and suburban land, made by the old-established auctioneers and valuators of Melbourne in the land boom days, their banks would never have closed their doors.

Every bank should keep a laughing department where absurd valuations and ridiculous securities could be laughed off the premises. The easiest marks as borrowers were the building societies and the land and estate agents, and they had a right royal time asking for and getting advances. In those halcyon days nobody was ever refused a loan by a bank manager. So the banks opened agencies in Scotland, Ireland and England, and borrowed millions on deposit receipts for 18 months and lent them out in Victoria for 30 years, and a great deal of the money, for eternity.

It wasn’t a mad or pessimistic or despondent thing to do. It was one calling for laughter, for merriment, for jocosity.

Why should the good-humoured borrower explain to the dismal bank manager, irritated and worried by Head Office letters and circulars censuring him for not lending money fast enough, that though he had paid £1 a foot for land at Coburg or Glen Iris or Mentone that it was not in his own opinion worth the £10 a foot of his own valuation.

Nobody dared to laugh at these insane transactions, nobody was brave enough to say,
” All this business is frenzied, delusive and pure buffoonery. There must be a smash.
” And there was. Prices of houses and lands jumped higher and higher, day by day, nay, hour by hour, and more and more people were drawn into the maelstrom, into a true Walpurgis ride to sudden wealth.

Rateable property in cities, towns and boroughs went up by leaps and bounds from £53 to £86 million sterling in 5 years, while the rateable property of shire councils jumped from £71 to £108 million in the 5 years 1886-1890. It was all so dashed funny, because there was no solid foundation for all this paper wealth.

Production did not increase part passu, nor overseas trade, nor exports, nor shipping, except that imports increased literally horribly. During 1886 and 1890 in Victoria, railways costing Z8 ,000,000 and 486 new churches and chapels were built. To me it was all so ridiculous and amusing, and the best of the joke was that none of the leaders of the people in Press, Parliament, Church, or on the platform, ever uttered a single word of warning about the coming debacle, The terrible catastrophe so close at hand which brought ruin to tens of thousands of decent people and nearly smashed Victoria.

Bank assets rose from £41m in 86 to £63m in 91.

Deposits grew from £31m in 86 to £40m in 91.

After that they fell away and did not reach £40m until 1907, or 28 years later. I am writing of what I know because I went through that critical period on the inside in a finance company and in a property company as an executive officer, and when the panic stopped I was a member of the Stock Exchange.

Value as determined by who? In terms of which inputs to achieve what outputs? As an example, a company experiencing challenges (or as I call them – problems) may need to hire more people to achieve long-term growth. However, if they do that Wall Street will hammer their stocks which will go down. If they cut their workforce instead, Wall Street will reward them by valuing their stocks even higher though the company has effectively sabotaged their future growth plans. Thus Wall Street is not doing price discovery so much as constructing their own outputs to be achieved by individual companies along some ideological goal. Perhaps they are trying to create the ‘perfect market’ by warping reality which is a neoliberal trait.

One aspect not touched upon is stocks are loans that never get repaid. If I pay $100 of a share and the company thrives. I get paid dividends in perpetuity. Plus, If I buy that share from someone who already had bought it (a trade) I am being paid when I actually provided none of the original loan (like a bank buying the “paper” from another bank). Someone calculated that the dividends paid by Apple have paid off the amount originally tendered by several hundred percent, which would make them the worst bank loans in all of creation.

Would not simple loans make more sense? (Yes I am aware of the abuses of the Japanese uses of banks, but they were abuses of a system, not the system itself that resulted in their decline.)

I am a bit more optimistic than the author on the role of stock markets in raising capital.

I agree with the post-issuance market largely being rent seeking and I think it should be thoroughly regulated and enforced. However, the post issuance market is essential to provide the reason to provide the capital at issuance. Pure rent seeking, such as high frequency traders front-running transactions because they are physically closer to the stock exchange should be banned outright.

However, I think the author is wrong about the stock market being an exit mechanism is generally wrong. Entrepreneurs are inherently optimistic people. I believe most stock issuance, especially by new firms in non-bubble markets, are in the hope and belief that with this capital they can move forward and grow. But as anybody who watches restaurants openings and closing, new businesses are very difficult to make a go of it and a high percentage fail or wallow. But ultimately some do make it work, like Apple, Microsoft, Amazon etc. and go on to grow exponentially.

Our economy has historically grown substantially with a general improvement in everybody’s lives. It should be expected that the overall stock market should provide the financial growth to follow this economic growth in the long run. So people like myself are simply hitching our financial wagon to the belief that things improve over time and the markets will follow in general. That is the underpinning of index investing – if you invest in everything, you don’t need to know who the winners are in advance because you will have them. So over the years I have simply devolved my investing style into a blend of broad index and value index with some bonds and cash to reduce volatility. Since I include international stocks in that, I am simply betting that the world will continue to improve in general so that people who didn’t have toilets and clean water a decade ago will have it 10-20 years from now and then increase their comfort level beyond that over time.